A bank expects to raise $20 million in new money if it pays a deposit rate of 7%,$60 million in new money if it pays a deposit rate of 7.5%,$100 million in new money if it pays a deposit rate of 8%,and $120 in new money if it pays a deposit rate of 8.5%.The bank expects to earn 9.5% on all money that it receives in new deposits.What deposit rate should the bank offer on its deposits,if it uses the marginal cost method of determining deposits rates?

Question

Quizplus · Accepted Answer

The marginal cost method involves setting the deposit rate equal to the marginal cost of obtaining funds from depositors. The marginal cost in this scenario is the interest rate the bank expects to earn on the new deposits, which is 9.5%.

To determine the optimal deposit rate, the bank needs to find the point where the marginal cost intersects with the demand for deposits. From the given information, we can see that the bank expects to raise $20 million at a deposit rate of 7%, $60 million at 7.5%, $100 million at 8%, and $120 million at 8.5%.

Based on these numbers, it seems that the demand for deposits increases as the deposit rate increases. However, the bank needs to balance the cost of obtaining funds with the potential return on investment. Setting the deposit rate too high may lead to a situation where the bank cannot earn a sufficient return on the new deposits.

Therefore, the best choice is to offer a deposit rate of 8% which allows the bank to raise a large amount of deposits while still earning a reasonable return on investment.

A Bank Expects to Raise $20 Million in New Money